Despite briefly losing its crown as the world’s most valuable technology company to chipmaker Nvidia (NASDAQ:NVDA), software giant Microsoft (NASDAQ:MSFT) has continued to rally to new heights and could very well continue to do so.
The tech company’s direct exposure to novel artificial intelligence technologies as well as cloud computing will also help to keep Microsoft’s growth engine running.
MSFT shares have rallied 21.9% on a year-to-date basis as of the end of Monday’s trading session. Below are 3 reasons why the famed software stock will edge up even higher.
AI Investments
OpenAI catapulted into the mainstream zeitgeist once the startup released ChatGPT, the world’s first generative AI chatbot.
While ChatGPT and OpenAI received much attention, commentators also focused on Microsoft’s role in making the chatbot possible. Way back in 2019, Microsoft invested $1 billion into OpenAI. A series of emails reveal the reason why.
According to the Verge, the software giant feared it was behind competitor Google, a subsidiary of Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), in terms of machine learning capabilities.
Upon consideration of an investment into OpenAI, CTO Kevin Scott wrote to CEO Satya Nadella in an email, “We are multiple years behind the competition in terms of machine learning scale.”
Nowadays, Microsoft has invested more than $13 billion into OpenAI, and the software giant leverages OpenAI’s large language models throughout its Microsoft product suite, driving user productivity.
OpenAI’s LLM is best in class, and while Google has made significant strides in producing its own advanced LLM, Microsoft’s hefty investment into OpenAI seems to have paid off.
Azure will be an AI workload behemoth
Microsoft, of course, has not stopped at a direct OpenAI investment and various product integrations of the startup’s LLM in its race to become a force to be reckoned with in the AI space.
The software giant’s cloud platform, Azure, remains a key growth engine. Cloud computing has its own secular tailwinds guiding its growth trajectory: that is, enterprises are increasingly adopting cloud-based products.
Because workloads for advanced LLMs are concentrated in large-scale data centers, Azure has seen a surge in revenue growth.
Microsoft’s “Intelligent Cloud” business reported $23.7 billion in revenue in the company’s third quarter report for fiscal year 2024; the sales figure represented a 21% year-over-year increase from the same period in 2023.
Revenue, particularly from “Azure and other cloud” products, grew 31% year-over-year. About 7 percentage points of Azure’s growth was related to higher demand for AI workloads.
That is to say, there is a lot of demand for LLM training and Microsoft’s Azure is, so far, successfully meeting that demand.
Not Unreasonable Valuation
To conclude this discussion, let’s think about Microsoft’s valuation. According to Koyfin, the software company trades at a pretty high 36.1x forward earnings.
This is well above Alphabet’s or Meta’s valuation, which sit around 23.8x forward earnings and 24.8x forward earnings, respectively. Though Microsoft is clearly trading at a stark premium to some of its peers, we also have to ask ourselves if that premium is justified.
Alphabet has created a compelling AI product and Google Cloud has experienced tremendous growth in recent quarters, but these have yet to reach the scale of what Microsoft is currently offering in the space.
Not to mention, if we’re speaking about boasting high trading multiples, Microsoft is also joined by Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), and Nvidia. That is to say, while Microsoft’s valuation is high, it’s not out of this world.
On the date of publication, Tyrak Torres did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
